When we are looking for home loans, we tend to go with the loan product that charges the lowest rate of interest. What if the bank were to charge you a negative interest rate? Essentially, the bank pays you to take a loan from them. Not possible? Well, a Danish Bank has just done that. Jyske Bank, Denmark’s third largest bank, is offering 10-year mortgage at -0.5% p.a. Technically, it is not a pure home loan. It is an add-on loan on an existing mortgage. However, a negative interest rate home loan is still a novelty.
Why would a bank offer a home loan/mortgage with a negative interest rate? How would the bank make money on such a loan? Well, Government bonds yields in Japan and a few European countries are negative. So, the concept of negative interest loans is not entirely new. For more on why investors would opt for negative rates or yields, here is a primer on Investopedia. When it comes to loans, the bank is the investor and you are the borrower. The aforementioned Danish bank says it can borrow from institutional investors at a negative rate and is passing on the cost benefit to investors.
In India, we are nowhere near negative interest rate home loans. We have a much higher rate of inflation and have higher deposit and loan interest rates. The inflation rate in Denmark is much lower, around 1%. Negative interest rates on deposits can also be policy to dissuade investors from saving money and instead spend it. This is to provide fillip to the economy. Not easy to achieve desired results though. On a side note, the rental yields in Denmark are about 6% p.a. (basis feedback from a client based in Denmark). There are banks offering 20-year mortgage at 0% and 30-year mortgage at 0.5%. The inflation is less than 1%. The residential real estate makes for an awesome investment in Denmark. Contrast this with real estate in India. The rental yields are 2-2.5% p.a. The loan interest rate is 8.5-9% p.a.
This post is not to explain economics behind negative interest rates. My understanding of economics is quite limited too. It is a fun post to understand how negative interest rate loans would work for you.
How Will a Negative Interest Rate Mortgage Work?
I used the usual PMT function to calculate EMI for Rs 50 lacs loan at -0.5% p.a. and a loan tenure of 20 years. The EMI shall be Rs 19,804. I assume the loan interest rate remains constant during the loan tenure. Over the loan tenure, you will end up paying a total of Rs 47.53 lacs (Rs 19,804 X 240 months). For a loan of Rs 50 lacs, you just need to pay Rs 47.53 lacs over 20 years.
Negative interest rate does not mean that the bank would offer you cash pay-out every month. However, the bank would do something similar. Each month, the principal outstanding will go down by more than the EMI amount. This would never happen in a regular positive interest rate mortgage.
Here is how the loan repayment would look like.
|Month||Principal O/S at the beginning of the month||EMI||Interest||Principal repayment||Principal O/S at the end of the month|
As you can see, principal repayment per month is greater than the EMI itself. To arrive at principal repayment every month in reducing balance loans, we deduct interest component from the EMI, Since the interest component is negative, the principal repayment is more than the EMI.
This is how annual principal repayment would look like.
|Year||Principal Repayment in the year||Total EMI paid in the year|
You can see a principal repayment is higher in initial years. This is in sharp contrast to regular home loans with positive interest rate. Reason: Negative interest rate. The more negative the interest rate, the lesser principal you would have to pay. At -1% interest rate, you would have to pay only Rs 45.14 lacs over 20 years to settle a loan of Rs 50 lacs.
Never Forget You Are Dealing with a Bank. There Is No Free Lunch
We just talked about the interest rates. What about the processing fee and other miscellaneous charges? What if the bank uses negative interest rate as a level to force you to buy third party products? In the illustration on the bank website, you must still pay back 277,392 DHK for the loan amount of 250,000 DHK for a 10-year loan. This is because of various fees and taxes. In nutshell, you pay negative interest rate on a higher amount than the disbursed amount. The effective interest rate is low nonetheless. And the bank is still making some money.